Short- and Long-Term Interest Rate Inversion Realized "Recession Signal Opinions Divided... Still Early Stage"

[Asia Economy Reporter Lee Seon-ae] Since the inversion of the long- and short-term interest rates became a reality, market opinions have been divided on whether it signals an economic recession. In this context, stock market participants are advised to focus more on whether the inversion will actually lead to a recession rather than the inversion itself.

On the 7th, Meritz Securities judged that it is still too early to view the long- and short-term interest rate inversion as a signal of an economic recession. Meritz Securities advised, "Regardless of whether the predictive power of the long- and short-term interest rate inversion is right or wrong at this point, since it has been a fairly effective signal in the past, it is necessary to analyze separately the cases where the inversion was followed by an actual recession and those where it was not."

Since the beginning of the year, as inflation in the U.S. intensified, expectations of policy acceleration were reflected in short-term interest rates, while concerns about economic slowdown were reflected in long-term interest rates, causing the spread between long- and short-term interest rates to narrow rapidly. In this trend, on the 1st, the 10-year and 2-year U.S. Treasury yields recorded 2.38% and 2.46%, respectively, resulting in a yield spread inversion of -7.4bp (bp = 0.01 percentage point). Typically, an inversion of long- and short-term interest rates is interpreted as a signal of recession, but in 1998 and 2019, no recession occurred within 12 months after the inversion.

Since 1977 until this year, there have been a total of seven instances of long- and short-term interest rate inversion. Among these, five led to economic recessions. In those cases, from 5 to 7 months after the inversion, the Institute for Supply Management (ISM) Manufacturing New Orders Index fell below the baseline of 50, and the Leading Economic Index year-over-year change dropped below zero.

The cases where the interest rate inversion did not lead to a recession were in 1998 and 2019. In 1998, an inversion of less than 7bp between the 10-year and 2-year yields appeared from June to July, but the year-over-year change in the Leading Economic Index remained positive, and although the ISM Manufacturing New Orders Index fell below the baseline for four months after the inversion, it quickly recovered. Initial jobless claims decreased until the first half of 2000.

In 2019, the 10-year minus 3-month yield inverted in March, and the 10-year minus 2-year yield inverted in August. After August, when the U.S.-China trade dispute intensified, the New Orders Index remained below the baseline for five months, but thanks to the first phase trade agreement between the U.S. and China in December, it rose above 50 again from January, and the Leading Economic Index also rebounded.

Of course, a common factor in these two cases was the preventive monetary policy of cutting interest rates before the recession became a reality. In 1998, interest rates were cut by 75bp from September to November, and in 2019, by 75bp from July to October.

Hwang Su-wook, a researcher at Meritz Securities, explained, "If we consider the year-over-year change in the Leading Economic Index, initial jobless claims, and the ISM Manufacturing New Orders Index as criteria, it is still too early to worry about a shock," adding, "In particular, stock prices have been determined by trends reacting to economic indicators rather than the interest rate inversion."

He pointed out the current △7.6% year-over-year increase in the U.S. Conference Board Leading Economic Index in February △the ISM Manufacturing New Orders Index of 53.8 in March, exceeding the baseline of 50 △and the continuous decrease in initial jobless claims since COVID-19.

However, he expressed concern that broad-based raw material-driven inflationary pressures are exacerbating supply disruption issues. The ISM Manufacturing Price Index, which had been declining since its peak in June last year, rose again to 87.2 in March. Researcher Hwang emphasized, "In the March ISM Manufacturing sector comments, many sectors cited supply chain problems and price pressures as significant obstacles to business activities," adding, "We need to closely monitor whether supply chain issues caused by rising prices will continuously suppress new orders."

This content was produced with the assistance of AI translation services.